Tuesday's news that three home healthcare providers - Amedisys (AMED), Gentiva Health (GTIV) and LHC Group (LHCG) - could face criminal prosecutions for allegedly "gaming" the Medicare system dealt a devastating blow to all three stocks. In response to the fears of a probe based on the Congressional report released this weekend, Amedisys has dropped 22% in the last two days; GTIV 45%, and LHCG by 12%.
The carnage in the impacted stocks also spread to other home providers - Almost Family (AFAM) dropped 11% on Monday - and hospitals such as Tenet Healthcare (THC) and Kindred Healthcare (KND), though much of that damage was mitigated in Tuesday's trading.
The news was just the latest in a difficult year for home health care companies and their stocks. The federal debt ceiling deal on August 1 hammered stocks across the sector, as fears abounded of Medicare cuts from the so-called "supercommittee" charged with finding budgetary savings in the absence of a negotiated budget deal. A few weeks earlier, the Center for Medicare and Medicaid Services proposed a 3.35% cut in the Medicare reimbursement rate for home health services in 2012. (This was actually a less painful cut than many feared, though the new negative publicity toward the sector may limit lobbying efforts and put an increased cut on the table.)
The continued pressure on the sector's top line has weighed on stock prices. Here's the YTD chart for the industry's four largest publicly traded companies:
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The slide in stock prices has created some eye-catching fundamentals. GTIV now trades at a P/E of 2, AMED 4, and LHCG 6.5, with all three stocks at least at a five-year low.
But value investors looking in the bargain bin should be very careful, and heed the lesson of another government-reliant industry: the for-profit education sector. For-profit education companies receive around 90% of their revenue from the federal government - a percentage similar to that of home health care agencies - through Pell Grant and subsidized loan programs. The sector had been flailing for over a year - falling 40% as a whole - before, on June 2, long-awaited regulations were passed by the Department of Education. For-profit colleges spiked 17% before closing the day up 12%. Investors cheered the demise of potentially "draconian regulations" and improved clarity. From Reuters:
A watered down rule for the U.S. for-profit education industry ends more than a year of uncertainty that has weighed on the colleges and their stocks, and sets the stage for renewed earnings growth and potential industry consolidation ... Analysts said the latest changes were a big win for the for-profit industry, which has been under the cosh for more than a year as the government sought tougher regulation.
The relief didn't last long. Three days later, the Arizona Republic reported that a number of state attorneys general were investigating the schools, and that a multi-state class-action lawsuit was possible. Democratic Senator Tom Harkin, disappointed with the proposal, convened hearings on the industry in response. In August, the Department of Justice filed a whistleblower lawsuit against Education Management (EDMC), alleging that the company ignored federal regulations against compensating recruiters for the quantity, rather than quality, of students admitted. In September, two other senators called CEO Wallace Boston of American Public Education (APEI) to testify in relation to for-profit colleges' treatment of veterans and active-duty members of the military. The White House Office of the Inspector General piled on a week later, with a report alleging a "serious vulnerability" in online education (government-speak for alleged fraud), and for-profit education shares fell further. A day later, the Republican-controlled House made the industry a bipartisan target, recommending cuts in the Pell Grant program, a key revenue source for the industry.
The cumulative impact of the regulatory action crushed for-profit education stocks. Here's the three-month chart of the Bloomberg US For-Profit Education Companies Index:
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USEDU 3-month chart; courtesy Bloomberg
The sector has taken a one-third haircut in three months, with the drop over 35% from peak to trough.
The pattern is repeating. In July, when the 3.35% cut was proposed by CMS, Reuters ran an analysis entitled: "New rules won't put healthcare on life support," with the following quote:
"The 2012 proposal is likely better than most investors' expectations ... this should signal investors that CMS is not aggressively 'going after' the industry as many fear," Ellen Spivey of Stephens Inc said.
"It is not the worst case scenario. The cut could have been 5-7%."
Shares of the top home health providers have dropped by 20-30% in the last six months, dragged down by the increased scrutiny and uncertainty.
Sound familiar? It's the same logic used to promote for-profit education stocks after the release of "favorable" regulations. The markets had priced in the worst, the argument goes. With the worst off the table, the stocks are bound to rise.
Yet the analysts are missing two important points about government-reliant sectors.
First, when the government has you in its sights, it is very difficult to wriggle free. For-profit colleges have, in three months, faced subpoenas, hearings, potential subsidy cuts, and/or investigations from all three branches of the federal government and a number of state attorneys general, including members of both parties. Does anyone doubt that home health care companies - or any Medicare provider, for that matter - will not face the same pressures from the same variety of sources? Once a reimbursement is cut, why won't the CMS - or Congress, or the budget supercommittee - add on, since it's clear that the providers weren't bankrupted by the initial reduction in reimbursements? Once investigations are launched, why won't another branch, or another state, or another sub-committee, launch a new one, piggy-backed on the revelations of the prior probe? Arguing that "the worst is over" for home healthcare stocks, or that regulatory interference is somehow "priced in" by the recent declines, is a very dangerous assumption, particularly in this political climate.
Secondly, and more importantly going forward, businesses in these sectors have no one left in the political system to defend them. Democrats - particularly the more liberal-leaning in the party - are traditionally less indulgent of, or far more hostile to, business interests than Republicans, depending on your point of view. Yet the GOP-- the traditionally stalwart defender of corporate interests, for good or evil, again depending on your point of view - has made deficit-cutting such a priority as of late that their protection of corporate subsidies can no longer be taken for granted. Considering all the talk about a "broken political system" and the rise of partisanship, it seems we should at least thank Medicare providers and for-profit college operators for giving Republicans and Democrats common cause.
This ray of hope for our political climate (please note, I'm being sarcastic) should send chills up the spine of investors in home healthcare stocks right now. Yes, the valuations look good, on paper. In the spring, valuations looked good for many of the for-profit stocks whose investors have seen losses of 30-60%.
Home healthcare stocks are a target right now - in an election year, no less. The regulatory and reimbursement pressures will not end. Ask investors in for-profit colleges what that kind of pressure can do to one's portfolio.